In a nutshell:
With ARM loans, interest rates can change yearly after an initial fixed rate period as the economy fluctuates. This loan type is riskier than a traditional fixed-rate mortgage because the market can fluctuate wildly, but it can also yield lower interest rates. In essence, a 1-year adjustable-rate mortgage is like taking out a 30-year loan that refinances itself once a year without any closing fees.
- Obtaining a one-year ARM allows the buyer to qualify for a larger loan and purchase a nicer house.
- If interest rates rise significantly, the buyer could take a financial beating.
Buyers also have the choice of an interest-only loan, in which the first few years of payments go toward paying off the interest only, and a balloon mortgage, which offers lowered rates with a huge payment due at the end of the loan.